European commercial real estate investment volumes drop
26 May, 2008, Europe
The full force of the credit crunch is now being felt by the European commercial property market. According to new research released by Cushman & Wakefield, investment volumes in the first 3 months of the year fell 37% on the same period in 2007, while yields rose at their fastest since 1992. In the UK, volumes fell 52% over the same period. With confidence shaken and uncertainty over pricing impacting almost as much as the lack of affordable debt, the market is ready for more to come.
To date, however, the occupational side of the market has held firm, with prime rents rising 11% in the year to March. As a result, total returns have remained in positive territory, with an all-sector prime average of 7.1% for Western Europe. The question is whether such performance can be sustained once the economic impacts of the financial market turmoil start to show in job cuts, tighter borrowing and increased risk-aversion. In addition, the threat of stronger inflation highlights the continuing downside risks to performance.
“We currently expect rental growth to ease to around 3-4% at best this year” commented David Hutchings, head of European Research at Cushman & Wakefield. “However, with markets in general not oversupplied and development being cut back by current trends in financing, building costs and risk appetite, an upturn in the market in 2010 could well deliver strong performance for investors. A growing number of equity investors appear ready to take advantage of this and look set to re-enter the market as soon as financing markets stabilise. As a result, we are still optimistic that the market will recover more rapidly than some seem to expect.”
Nonetheless, with an uncertain outlook for the months ahead, it is no surprise that investors now are in a cautious and demanding mood.
According to Michael Rhydderch, Head of the Cross Border Capital Market team at Cushman & Wakefield, “Deals are taking longer and the due-diligence process is more protracted. Where funding is required, the extra scrutiny put in place by the banks adds further to the delay and uncertainty of transactions actually completing.”
At the same time, many vendors are reluctant to accept the offers available to them. Some face few attractive re-investment options and are choosing to sit firm or extend the life-span of their funds.
According to Michael Rhydderch however, “some investors are yet to accept the reality of the market or purchasers’ views on risk and this mismatch in opinions has inevitably meant lower level of activity recently.”
Most markets have seen a decline in activity as uncertainty has spread, with only a handful, including Austria, Bulgaria, Denmark and Finland, seeing trading improve on the first quarter of 2007. Spain and the Netherlands also saw an improvement on the back of large portfolio deals. In the UK, after marked falls over recent months, activity has at least stabilised, with the first quarter nearly matching the performance of late 2007.
Somewhat against expectations, it has been cross-border buyers who have reduced activity the most – with their share of purchasing down to 47% as against an average of 54% in 2007. In part this reflects the drop off in larger portfolio and trophy asset deals, an area dominated by foreign players. Also, however, in some markets, domestic buyers have been ready to take advantage of the more cautious approach of foreign players.
“This trend may continue in the coming months as some foreign buyers stand back, expecting a uniform shift in pricing even though local market conditions may not warrant this.” speculated Michael Rhydderch.
Nonetheless, cross-border buyers are likely to make their presence more keenly felt as the year progresses. German open-ended funds are already in evidence and sovereign wealth funds are active in direct purchasing and in taking corporate stakes.
According to Michael Rhydderch, “More opportunistic players are heading East, with Turkey, Russia and the Ukraine experiencing strong levels of activity. With buoyant rental growth, averaging over 30% in the past year, investor interest in emerging markets is high.”
Yields for prime space rose on average 12 basis points in the first quarter, taking their increase since last summer to 35bp, with offices most affected. Secondary property has seen yields shift by 75-100 bp in most areas over the period. According to Hutchings “A further 15-25bp increase is yet to come for prime and 50-100bp for secondary, but as ever an over-reaction may be seen, particularly given the downside risk to economic growth”.
According to Michael Rhydderch, “This rapid re-adjustment in pricing is a sign of an increasingly professional market, but many investors will maintain a “wait and see” attitude until they have greater confidence in pricing and the economic outlook. The current lack of distressed sellers indicates an economy that, although weaker, is not in retreat. Nevertheless, even without high levels of distress, there are now that a growing range of opportunities are emerging from vendors who do want to do business.”
Cushman & Wakefield suggest that the economic situation is not, so far at least, as bad as some seem to think. While performance is polarising, taken overall, Europe still looks set to ride out the current global slowdown and avoid recession. At the same time, inflationary pressures should soften to allow the European Central Bank to cut interest rates later this year.
“On balance, the market will see further pain in the months ahead – with yields yet to peak and rental growth slowing – but in the latter part of the year, a firming in economic confidence allied to an increased supply of opportunities, should be the catalyst for a steady recovery in activity”, concluded Hutchings. “We currently expect total trading of €180-190bn, some way down on the 2007 record, but ahead of recent performance.”